Fundamentals of risk management

Heim breaks down risk into its ‘basic building blocks.’

Brian Heim, founder of IRR-analytics, broke down the fundamentals of risk management during a breakout session at the 2018 CUNA CFO Council Conference in Austin, Texas, on Monday.

Those fundamentals included:

Policy. “Policy is the mechanism for communicating the risk appetite of the credit union,” Heim says. “We really encourage our clients to use language that doesn’t use jargon that non-technical folks can understand.” Credit unions should avoid letting policies accumulate. Examiners will focus on risk limits, he says.

Technical model elements. Most credit unions use vendors to help them build their technical model element. Credit unions gather their core data, which is integrated into the model while applying certain assumptions. The No. 1 issue that Heim’s firm encounters with credit unions is overly optimistic assumptions. “The point of the modeling is to get an idea of what your risk exposure is,” Heim says. “It’s not to produce the most rosy and optimistic results you can come up with.”

Reporting. Heim says reporting is often overlooked, and it should be designed to be understood for the non-technical person. “It’s very helpful if other managers who aren’t familiar with finance can pick up your report and understand your risk profile just by looking at the first few pages.”

Model output discussion. This takes place when the model has created its output and the team has acknowledged any limitations in the results. “You want to avoid any implications of precision accuracy and certainty,” Heim says. “You want to focus on the magnitude and direction of risk, and understand your limitations.”

Discuss results for action or deliberate inaction. At this point, credit unions should consider if they are managing risk appropriately, and how they might proceed if another recession or financial crisis would occur. “You always need to talk about the trade-offs of reducing risk,” Heim says. “What the cost, and is the cost worth the benefit?”

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